Flawed Fed Predictions

We will, admittedly, put this one in the “not saying anything new” category, but Ben Steil’s WSJ op-ed from last weak bears highlighting. It features the sentence of the year so far: "In short, the Fed's premise that it can speak with authority about the future is flawed."

Here is how Steil came to this, not-so-surprisingly objective opinon:

The Fed studied its own staff's forecasting performance over the period 1986 to 2006. It found that the average root mean squared error—or the deviation from the actual result—for the staff's next-year gross domestic product (GDP) forecasts was 1.34, compared with 1.29 by what the Fed describes as a "large group" of private forecasters. That is, the Fed's predicting performance was worse than that of market-watchers outside the Fed. For next-year CPI forecasts, the error term was 1.03 for Fed staff, and only 0.93 for private forecasters. The Fed's conclusion? In its own words, its "historical forecast errors are large in economic terms."

How about the Fed's longer-term predictions? The Fed started publishing the Board of Governors' and Reserve Banks' three-year forecasts in October 2007. At that time, the GDP growth forecasts among this group of 17 ranged from 2.2% to 2.7%. Actual 2010 GDP growth was 3%, outside the Fed's range.

The Fed forecasters told us that unemployment in 2010 would be in a range between 4.6% and 5%. In fact, it averaged about twice that, or 9.6%. The forecasters further predicted that both Personal Consumption Expenditures inflation (PCE, similar to CPI) and core PCE inflation would be in a range from 1.5% and 2%. The former came in at 1.3% and the latter at 1%, again outside the Fed's range. The Fed's scorecard on its 2007 three-year forecasts: 0 for 4.